What is a 529 Plan?

A 529 plan is a college savings plan. These plans are run through individual states and provide tax benefits. Some 529 plans are prepaid tuition plans, but the majority of 529 plans are simply savings plans.

Here’s some important information that you need to know about 529 plans:

1. You can choose any state’s plan. So, you are not stuck with your home state’s college savings options. And this is good news because other states may offer a better plan.

2. You place after-tax dollars into the 529 plan, invest it, and then pull out the funds tax free for educational purposes. Removing the dollars tax free is a big deal because you avoid paying capital gains tax on the increase.

3. Contribution limits are usually extremely high, but you will want to check with the state’s plan for specific limits.

4. Withdrawals must be used for qualified educational purposes. These expenses include tuition, books, room and board, computer, and internet.

5. If your child decides not to go to college (or you don’t use all of the funds), you can always switch beneficiaries. Beneficiaries can be any qualified family member--spouse, child (or stepchild), sibling (or step-sibling), father (or stepfather), mother (or stepmother), first cousin, niece, nephew, aunt, uncle, father-in-law, or mother-in-law.

6. If you choose not to use it for the purpose mentioned above, you will pay both taxes and a penalty on the withdrawal amount.

7. You can also use a 529 plan to cover K-12 educational expenses, up to $10,000 per year.

With so many options, which 529 plan should you choose?

Focus on the three R’s—return, rating, rewards.

1. Return. Make sure you get a plan that delivers solids results over a long period of time (5 to 10 years). Do not get wowed by an amazing one-year return.

2. Ratings. See how the plan is rated compared to other plans. You can do this by going to savingforcollege.com. Since you have the ability to select from any state, choose the state that is regularly rated higher than its peers.

3. Rewards. Some states offer tax incentives for their in-state residents. While these are important to be aware of, they usually do not make up for poor comparative returns and ratings.

Follow my 8 Money Milestones. When you get to Milestone #7, consider a 529 plan your college savings. They are an incredible usual tool to help prepare you for those dreaded college expenses.